Educational Articles

An Update on Energy Prices

Robert Mitkowski
| February 15, 2011

The economic recovery that began in the spring of 2009 has lifted domestic oil prices to within striking distance of the psychologically significant $100- a-barrel level on rising worldwide petroleum demand. In fact, oil prices outside the United States have already touched triple digits, owing to the added call for crude from developing nations, notably China. Shares of oil producers, such as Exxon Mobil (XOM - Free Exxon Mobil Stock Report), and oilfield services companies, such as Schlumberger (SLB), have enjoyed nice rallies on prospects for a continuation of the trend toward more expensive petroleum.

The direction of oil prices is no sure thing, of course. On a daily basis, quotations are pushed and pulled by any number of factors. On the plus side, this winter’s cold and stormy weather has boosted consumption. Political turbulence in the sensitive Middle East also continues to keep prices higher than they might otherwise be. The fear is, of course, that events could snowball and disrupt supplies from a major oil-producing nation, such as Saudi Arabia. On the downside, OPEC’s hints that it may boost output, and slow employment growth stateside, negatively affecting sentiment.

The underlying trend in oil prices is clearly higher, though, based on rising demand from developing countries and the thinking that new supplies will be limited. The psychology almost boils down to whether the glass (in this case the oil well) is half full or half empty. Currently, U.S. commercial crude inventories are within the range they have been over the past 20 years. But oil prices are much higher, owing to the perception that there will be difficulties in meeting future global demand.

Not enough big discoveries are being made to keep the oil market from being a little nervous about what will happen to oil prices in five or ten years. Most of what is being uncovered is in hard-to-reach locations, such as ultra deep water, the development of which pushes up the price of oil by being so expensive to produce. The Canadian oil sands are another resource that is being looked to for relief from rising global demand, but is costly to bring to market.

One compensating factor is that new drilling technologies have boosted onshore oil drilling prospects in the United States. Bustling activity in North Dakota’s Bakken Shale field and the Eagle Ford shale formation in south Texas is a throwback to the industry’s boom days. Service providers like Baker Hughes (BHI) and Halliburton (HAL) are benefiting in a big way as a result. But the added supply from these fields doesn’t appear as if it will change oil market dynamics all that much. Traders are still concerned that supply will have a hard time keeping up with demand in the years ahead.

The bottom line is that another push above $100 a barrel for oil prices seems almost inevitable in the not-too-distant future if the global economy keeps advancing at a 3.5%-4.0% rate, as it seems capable of doing.

Natural gas prices are not following oil’s lead, though. Similar drilling techniques used for unlocking oil from shale are also boosting natural gas supplies. But with natural gas more of a regional market (oil being worldwide), abundant supplies are pressuring gas prices. That is causing many producers to shift their drilling focus to oil. Meanwhile, a spillover effect of low natural gas prices is that they affect the marginal price of electricity. That’s keeping a lid on earnings prospects for power generators, such as Exelon (EXC), Entergy (ETR), and FirstEnergy (FE). The natural gas glut could last another year or two.

At the time of this article, the author did not have positions in any of the companies mentioned.